Feature

Deal of the Century?

As a stand-alone business, Verizon Wireless could be worth $300 billion—behind only ExxonMobil and Apple. Why Vodafone may sell its 45% stake this year—and why its shares could rise 20% or more. A 5.4% dividend.

Such a sale, which could reap more than $100 billion, probably would provide a nice lift to Vodafone (ticker: VOD) shares and a potentially smaller boost to Verizon stock (VZ). Shares of U.K.-based Vodafone, now around $28, might rise into the mid $30s, while Verizon, now at $49, could appreciate into the low $50s.

Verizon Wireless had 98 million subscribers at the end of 2012 and is expected to generate $81 billion in revenue this year. Earnings before interest, taxes, depreciation, and amortization, or Ebitda, could come in at $33 billion, according to Citigroup analyst Michael Rollins, with $23 billion of free cash flow after capital expenditures. With the country's most robust network, Verizon Wireless has captured more than 100% of the industry's net additions of so-called post-paid subscribers in seven of the past eight quarters. Post-paid subs get traditional monthly bills rather than prepaying for service.

What's Verizon Wireless Worth?

Est Value (bil)

2013 Sales

$81.0

2013 Cash Flow

33.7

Estimated Value*

269.6

Vodafone's 45% Stake

121.3

Verizon's 55% Stake

148.3

E=Estimate *Assumes a cash-flow multiple of eight

In a report last month, Rollins put the chance of a deal this year at 55%, noting that Vodafone probably can pull off the sale with only a modest tax payment of $5 billion. Favorable conditions in the capital markets would allow Verizon to finance a $100-billion-plus deal—which could be the second largest transaction ever based on Dealogic data—with a mix of debt, preferred stock, and equity.

AFTER YEARS OF SPECULATION about a deal, the rumor mill heated up last week as the Financial Times reported that Verizon and rival
AT&Tt -0.9705793145283591%AT&T Inc.U.S.: NYSEUSD32.65
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27.436974789915965Market Cap
171119844265.342
Dividend Yield
5.758039816232772% Rev. per Employee
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(T) were considering a joint bid for all of Vodafone. That prompted a denial from Verizon and a reiteration that it would be a "willing purchaser" of Vodafone's 45% stake in Verizon Wireless. The Wall Street Journal reported in February that Vodafone is open to a sale, with its CEO, Vittorio Colao, saying, "I don't know," when asked whether Vodafone would still hold that 45% stake in a year.

Both Vodafone and Verizon shares have rallied this year on hopes for such a deal. Vodafone's U.S.-listed shares are up 12% to $28 after hitting a high of $30 at midweek. Verizon shares, at $49, have gained 14% this year.

Vodafone's stock, which has lagged behind Verizon's in recent years, looks like the better bet. It trades for a lower price/earnings ratio than Verizon and has a higher dividend yield. Vodafone, which has wireless businesses throughout Europe, fetches about 11 times projected profits in its fiscal year ending in March 2014 and yields 5.4%. Verizon trades for nearly 18 times estimated 2013 profits and yields 4.2%. The P/E discount of Vodafone relative to Verizon is near its widest point in the past nine years.

In a note last month, Citigroup analyst Simon Weeden stated that "the low-interest-rate environment, strong operating performance from Verizon Wireless, improved balance-sheet flexibility at Verizon, strong dollar relative to sterling, and the increase in U.S. telco valuations are all favorable factors" for a deal. He carries a $32.50 price target on Vodafone shares. If Vodafone gets a top price for its stake, he thinks the shares could reach the mid to high $30s.

One Vodafone fan is Greenlight Capital chief David Einhorn, who wrote in his annual investor letter that there is a "huge valuation disparity between what the market thinks Verizon Wireless is worth to Verizon…and what it ascribes to Vodafone."

What's Verizon Wireless worth? The Citi analysts value it at seven to nine times estimated 2013 Ebitda, or a range of $236 billion to $303 billion. At a multiple of eight, it would be worth $269 billion, or about $116 billion for Vodafone's stake after estimated taxes. That's almost $24 per Vodafone share. Vodafone's core business, mostly European wireless, generates about $20 billion in annual pretax cash flow. That means Vodafone, ex Verizon Wireless, would be valued at just three times annual cash flow, reflecting its $35 billion in net debt.

The Bottom Line

Vodafone's shares could climb 20% or more if it sells its 45% stake in Verizon Wireless to Verizon Communications. In the meantime, investors collect a rich 5.4% dividend yield.

Verizon, excluding Verizon Wireless, appears to be valued at seven times annual cash flow of about $9 billion, reflecting its net debt of $40 billion, pension and health-care obligations. Citigroup's Rollins argues that a deal could boost earnings by more than 50 cents a share annually.

Vodafone needs to weigh the huge financial benefit from a Verizon Wireless sale with the risk of exposing itself more fully to the tough European wireless market, where competitive and regulatory pressures are strong. That's not an easy call, but the potential proceeds from a sale may be too much for Vodafone to pass up.

The deal of the century could be getting nearer.

Telco Titans

Vodafone's stock is cheaper than its U.S. counterparts' and sports a higher dividend yield.